Sustainable Property Investment and Valuation

All-risks yield method

Streams of payments: annuity

 Annuity
 A sequence of payments…
 of a fixed amount…
 due at equal time intervals

 In other words
 Payments of an amount a are to be made once a year for n
years, the first one due a year hence

a1 a2 ..... an
A0 An
Streams of payments: annuity

 Let us introduce the Present Value Factor PVF(r,n) for an

annuity
 PVF(r,n) = 1 / (1 + r)1 + 1 / (1 + r)2 + … + 1 / (1 + r)n
 PVF(r,n) = 1 / q1 + 1 / q2 + … 1 / qn
 PVF(r,n) = (qn–1) / (r * qn)

 It allows us to express the Present Value PV of an annuity a

in a concise form
 PV = PVF(r,n) * a
Streams of payments: an example

 Consider a loan of 1,000 Euros to be paid back in 5

consecutive yearly intervals at an interest rate of 10%,
what is the amount of the annuity to be paid?
 PV = PVF(r,n) * a
 a = PV / PVF(r,n)
 Hence
 a = 1,000 / PVF(10%,5)
 a = 1,000 / (1.15–1)/(0.1 * 1.15)
 a = 1,000 / 3.7908
 a = 264 Euros
Streams of payments: perpetuity

 A perpetuity is an infinite sequence of payments of a fixed

amount a occurring at the end of each year

 By letting n → ∞
 PV = limn→∞PVF(r,n) * a
 Hence
 PV = a / r
Valuation approaches, methods, and models

 According to the International Valuation Standards (IVS),

the value of a property can be identified following different
appropriate valuation approaches, each of which includes
different, detailed methods of application and related
models

 The hierarchical structure has three approaches at its top

level
 Market approach (based on the economic principle of market
equilibrium)
 Income approach (based on the economic principle of
anticipation of benefits)
 Cost approach (based on the economic principle of
substitution)
Valuation approaches, methods, and models

 “The purpose of any method of valuation is to determine

the price at which it is expected that a property asset might
change hands in the open market.”

 Models are subsets of a given method, they “should

therefore attempt to reflect how the buyers in that market
would assess the market value of that property.”
French, N., Gabrielli, L. (2018). Pricing to market - Property
valuation revisited: the hierarchy of valuation approaches,
methods and models, Journal of Property Investment &
Finance, 36(4), 391-396, DOI 10.1108/JPIF-05-2018-0033.
Valuation approaches, methods, and models

 Market approach
 Comparable method

 Income approach
 Investment method
 Income capitalization model
 Explicit Discounted Cash Flow model
 Profits method
 Residual method

 Cost approach
 Depreciated replacement cost method
Income approach

 Investment method
 “Value is based upon an actual or estimated income that
either is, or could be, generated by an owner of the interest.
In the case of an investment property, that income could be in
the form of rent; in an owner-occupied building, it could be an
assumed rent (or rent saved)”

 Income capitalization model

 “Income capitalisation (implicit), where an all-risks or overall
capitalisation rate is applied to a representative single period
income to determine the capital value”
French, N., Gabrielli, L. (2018). Pricing to market - Property
valuation revisited: the hierarchy of valuation approaches,
methods and models, Journal of Property Investment &
Finance, 36(4), 391-396, DOI 10.1108/JPIF-05-2018-0033.
Income capitalization model

 In the Income capitalization model, the value of a property

is identified by establishing a relationship with the rent
paid, by means of an all-risks yield

 Let us define V the unknown value of a property, R the rent

paid, and y the all-risk yield
 V=R/y
Income capitalization model

 Notice that the rent R is assumed to be received in

perpetuity

 The reason is easily understood when considering that

 If we assume a high discount rate (e.g., a 10% yield per
annum), as the time period n over which the rent received
goes beyond about 50 or 60 years, the present value of the
rent levels out to a fraction of the original value
 In other words, as n gets bigger, the 1 / (1 + r)n term gets
smaller, therefore, any stream of rent receivable for 60 years
or more may be regarded, to an acceptable degree of
accuracy, as receivable in perpetuity
 It means that freehold and long leasehold properties can be
valued by simply dividing the rent by the yield
Income capitalization model

 If the rent R cannot be assumed to be received in

perpetuity

 V = R * [(1 + y)n – 1] / [y * (1 + y)n]

 Consider, for instance, the following cases

 Shopping centers, malls, retail parks
 Movie theaters
 Gas stations
Income capitalization: an example
 Example: the valuation of hotels and accommodations
 IN (accommodation income) = EDBUs (number of rooms:
equivalent double bed units) * NN (number of nights: usually
365 nights a year, except for seasonal hotels) * OR
(occupancy rate: percentage of occupied EDBUs during a set
period, usually a year) * AR (average EDBU rate)
 GT (gross turnover: revenue) = IN (accommodation income)
+ AI (additional income, e.g., catering, parking, spa and
beauty center, gym, and so forth, where AI ~ IN * x, with
6% ≤ x ≤ 41%)
 NOI (net operating income) = GT - OE (operating expenses)
Otherwise
 NOI (net operating income) = GT * NOIm (NOI margin)
 PMV property market value = NOI / CAPRATE (capitalization
rate)
Income capitalization: an example

 Examples of equivalent  Examples of occupancy rate

double bed unit (EDBU)
calculation
Income capitalization: an example

 Example: the valuation of hotels and accommodations

IN (accommodation income) = EDBUs (number of rooms:
Valuation of the 4‐star hotel ֍֍֍֍֍֍ located in the city of ֍֍֍֍֍֍


Parameter equivalent
Unit of measure double
Value bed units) * NN (number of nights: usually

365 nights a year, except for seasonal hotels) * OR

(occupancy rate: percentage of occupied EDBUs during a set
EDBUs n. 112
NN period, n. usually a year) * AR
365 (average
HS avg. Rate (1) HSEDBU
nights rate)
LS avg. Rate (1) LS nights
OR pct. 63% Euros n. Euros n.
AR  GT (gross turnover: revenue)
Euros ←170.5 = IN (accommodation income)
250 75 150 290

+ AI (additional income, e.g., catering, parking, spa and

(1) Net of VAT (Value added tax)

beauty center, gym, and so forth,

x where AI = AN * 8-12%)
IN Euros 4,392,360 pct.
AI  NOI (net operating income)
Euros 1,229,861
← = GT
28% - OE (operating expenses)
GT Euros 5,622,221
Otherwise
5‐star 4‐star 3‐star
 NOI (net operating income) GT * NOIm (NOI margin)
pct. pct. pct.
NOIm pct. 21% ← 16% 21% 26%
NOI

CAPRATE
PMV property market value = NOI / y (capitalization rate)
Euros
pct.
1,180,666
7%
PMV Euros 16,866,662
All-risk yield

 The yield as the summation of different rates:

 y = rrf + rrp + rip

 where rrf stands for the risk-free rate (e.g., n-year Treasury
bond yield), rrp is the risk-premium rate, and rip is meant to
represent the illiquidity premium (e.g., +2% according to
the literature, see M. Hoesli et al.)
All-risk yield

 https://www.agenziaentrate.gov.it/portale/web/guest/sched
e/fabbricatiterreni/omi/banche-dati/quotazioni-immobiliari
All-risk yield

 V = 4,350 €/m2

 R = 13 €/m2 m  x 12 = 156 €/m2 y

 y = 0.036  3.6%
Investment comparison

 When the property value (V, e.g., the price paid) and the
market rent (R) are known, the capitalization formula can
be rearranged to derive the yield
 V=R/y
 y=R/V
References

 Wyatt, P. (2013), Property Valuation, 2nd ed. Oxford: Wiley

Blackwell.
 See paragraph 4.2.2, “Multi-period investments”.
 See section 6.2, “All-risks yield (ARY) methods”.

 Capinski, M., Zastawniak, T. (2011). Mathematics for

Finance: An Introduction to Financial Engineering, London:
Springer-Verlag (pp. 25-51).
 See paragraph 2.1.3, “Streams of Payments”.

 Isaac, D. (2002), Property Valuation Principles,

Basingstoke: Palgrave Macmillan.
Suggested readings

 French N., Gabrielli L. (2018), Pricing to market: Property

valuation revisited: the hierarchy of valuation approaches,
methods and models, Journal of Property Investment and
Finance 36(4), 391-396. Doi: 10.1108/JPIF-05-2018-0033

 Lorenz D., Lützkendorf T. (2011), Sustainability and

property valuation: Systematisation of existing approaches
and recommendations for future action, Journal of Property
Investment and Finance 29(6), 644-676. Doi:
10.1108/14635781111171797